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A Visit With a Tax Strategist

I had an interesting experience recently. A tax planner married to a doctor read my book. He had this to say:

I am a CPA that specializes in taxes. [My wife] purchased your book and we read it together and I have to say, I was very impressed. I have several physician clients and I will be referring your book to them. Still, when I read the part where you said that you do your own taxes I was skeptical. It is true that many CPA’s don’t specialize in aggressive tax planning, but I find it hard to believe that your tax bill is as low as it could be if you are doing your own returns.  Now that the tax deadline has passed and I have more time, I would like to issue a challenge: give me a copy of your 2015 tax return. Black out the names, address and the Social Security numbers and let me just see the dollar amounts. I am convinced I can show you some ways to save on your taxes. Prove me wrong.

I’m not sure how he was expecting me to respond, but I like to think my ego isn’t all that large and I’ve always got plenty to learn. I read this email as “here’s a CPA willing to give me a free tax strategy session and look over my taxes for errors.” All it would cost me is a little time via email and phone and copying and blacking out tax returns. Plus, I was well aware that my 2015 return was significantly more complicated than my previous returns had been. I was particularly concerned about all the tax forms I had to fill out with regard to selling my rental property in 2015, since that was the first time I’d done that and I spent a lot of time on it. I’ve never actually had a tax professional look at my tax returns, and I haven’t yet been audited. So who knew what he would find? I had a little worry that he would find I was underpaying my taxes by tens of thousands.

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So a few days after I sent Scott Keithly at Keithly & Glenn Tax Consulting, LLC most of my tax forms (I just couldn’t stand to copy, black out, and scan all 150 pages that Turbotax spit out) he got back to me with some great suggestions. Mostly, I was just happy that he confirmed I wasn’t dramatically underpaying my taxes and that I’d done the rental property disposition exactly right. He noted a few minor things I could have done better, particularly on the WCI partnership return I did this year for the first time (I guess we’ll find out how much the IRS cares about that) but really nothing worthy of filing a 1099X over. Which was good, since I had already done three of those this year! I was also curious about what he would charge to do my taxes and the figure came in around $1500, which was about what I would expect for such a complicated return. This year I definitely spent more than $1500 of my time doing them, but hopefully that’ll get easier in the future.

At any rate, I thought it would be fun to write about some of the suggestions he made to me. These aren’t suggestions in ways to fill out my tax forms better. They’re suggestions in ways to live my financial life differently that would lower my tax bill.

# 1 Form a C Corp

I’ve written before about C corps, years ago. There was this post about the benefits, this one about the downsides, and this one about how lots of doctors mistakenly think incorporating is the key to reducing their liability and taxes. However, when I wrote those posts, my financial life was significantly different- almost all my income was from my practice and WCI wasn’t making squat. It was reasonable to reconsider a C Corp for WCI.

The big problem with C Corps is the double taxation issue. Yes, a corporation may have a lower tax rate than you on a limited amount of income, but when you pull that money out, it is taxed again at your qualified dividend rate. Once you’ve been double taxed, there isn’t all that much benefit there. You minimize this double taxation by just paying out all profits every year as wages. By doing that, you get any side benefits of having a corporation and pay about the same amount in income taxes. The other issue with a C Corp is the expense and hassle associated with forming one, maintaining one, and dissolving one. So you’re really weighing the side benefits against those costs and hassles. So my discussion with Scott was about the side benefits.

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Here were the benefits that I could personally use if I incorporated. Be aware that most of these work for me because I’m a business owner, not a doctor and your situation will almost surely differ.

Decrease Medicare Taxes

Avoid paying medicare taxes on our employer 401(k) contributions. That’s $35K a piece, or $70K a year. 2.9% * $70K = $2,030.

HRA

Set up a Health Reimbursement Account (HRA) and pay for our health expenses using that rather than our HSA (or what we’re doing now, a taxable account.) This would allow us to pay for health care with pre-tax money while still allowing our HSA to keep growing. There would be some cost and hassle there for sure, but there’s potential to save $1-2,000 a year there given our high deductible. According to this, the maximum that can be put in there is about half your deductible, so $4500 a year given our current plan. If it isn’t used, it goes back to the employer, which is also me, so no big deal there. It could become a big deal if I start hiring non-family member employees for WCI though.

LTC

Pay for long term care premiums with pre-tax dollars. I’m not super interested in that option, as I plan to self-insure this expense.

NQDC

Set up Non Qualified Deferred Compensation accounts. Basically, this is a contract between me as an employee and me as a business that my business will retain some of my earnings, pay taxes on it at the lower corporate rates, and then pay it out to me at some later date. It avoids the double taxation issue because what is later paid to me and is fully taxable is a deduction for the corporation. So taking the money out, assuming the corporation is still making good money, is basically a wash from the tax perspective. Since the first $50K a corporation makes is taxed at 15%, the next $25K at 25%, and the next $25K at 35%, if I’m in the top bracket, there is an arbitrage there. If I just pulled that money ($100K) out and paid 39.6% on it, I would owe $39,600 in taxes. But if I did this, I would only pay 15%*$50K= $7,500 + 25% * $25K = $5,000 + 35% *$25K = $8,750 for a total of $21,750, a savings of $17,850 in taxes. (More if you include state taxes, especially if I move to a no-income tax state before withdrawing it.)

Now that gets me pretty excited. What’s the downside? Well, I have to incorporate. That means either learning more tax forms or paying someone else to do them. I also would have to pay an attorney to setup and dispose of the corporation. And I’d probably have to pay a company to do my payroll. But all that pales in comparison to $17,850 a year. What could go wrong? Well, WCI isn’t exactly GE. Who knows if it will be here and making good money in 20 years when I want to pull this money out. Without that deduction to offset my taxes on the withdrawals, I would end up just getting double taxed (it would end up being about 150% of what I would have otherwise paid.) This strategy would get even better if corporate tax rates are lowered. Clearly this could work great in the right situation, although I’m having trouble seeing where I would need to pull the deferred money out of WCI while WCI was still making lots of money. Maybe if I sold it, but then I’d have to worry about the new owners making good on the promised compensation. First world problems we’re dealing with here.

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Remember that doctors who form corporations for their practices often have to use a professional service corporation, which doesn’t get those lower tax rates on the first $75K of retained earnings. It’s all taxed at 35%.

My Thoughts On an S Corp

Now, I hadn’t really considered doing a C Corp, but I had seriously considered an S Corp for WCI in the next year or two. I really only want enough wages out of it to max out our 401(k)s, which we were barely able to do for 2015. But let’s say WCI hypothetically made $600K going forward. Well, we could take $200K each for wages, enough to max out our solo 401(k)s, and call the other $200K distribution and save the Medicare tax on it. That would save us $5800 a year, more as income goes up (if income goes up.) A C Corp couldn’t do that. But the potential tax savings from the C Corp could be larger for us, particularly when you include the NQDC.

# 2 Buying Life Insurance as a Business

Another thought Scott had, although he knew I probably wouldn’t go for it and he actually hasn’t ever had a client that did (he doesn’t sell insurance so has no reason to give the idea a “hard sale”), was the idea of buying cash value life insurance through the business. He knew I’m not big on either lots of leverage or cash value life insurance, but he thought it was worth mentioning. Basically, the way it works is you buy a huge whole life policy using borrowed dollars and use the policy as collateral on the loan. The premiums aren’t deductible to the corporation but the interest is. Then hopefully your tax savings is greater than your after-tax interest cost. I’ve written about a similar scheme before, and it won’t surprise any of you to see that I’m not going to be implementing this suggestion. However, he calculated the potential to save up to $43,600 in taxes. A video about this strategy might be worth debunking some time. Let’s just say I might save $44K in taxes, but I think I’d be better off skipping this option when all is said and done. It is clearly a great way to sell more insurance!

# 3 Using a Charitable Lead Annuity Trust

We give a lot of money to charity every year. It helps keep our taxes low as we deduct it on Schedule A. Scott suggested we might like to use a Charitable Lead Annuity Trust (CLAT) instead for our charitable giving. Remember with a CLAT that you put a big lump sum into a trust, get a tax break for it in this year, the charity gets something like 6% annuity payments every year for 18 years or so, and then you get what’s left. Meanwhile, the money is invested in something (like real estate) that hopefully earns more than 6% a year. So after 18 years, you get more money back than you put in, plus that big huge deduction 18 years ago. What you lose, however, are the costs associated with setting up the trust, all the taxes you owe on the earnings of the trust over the years, and the deductions you would have gotten from making annual cash donations to the charity from your earnings instead of the CLAT. I can see where this would work well for someone who is charitably inclined and received a big lump sum from the sale of a business or something and needed to lower his taxes in that year and who supports a single charity. For someone like me who expects to have rising income over the years (at least for a while) who supports multiple charities and doesn’t want to be locked into one, and needs ongoing tax deductions, I’m not sure it is so useful. There would be some benefit from the time value of money (i.e. getting the deduction up front) but I don’t think it works well for my charitable plans-i.e. contributing a percentage of my income each year.

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# 4 Oil and Gas Partnerships

I’ve frequently heard the phrase that the only investment that gets more tax breaks than real estate is oil and gas. As near as I can tell, that’s true. In fact, Scott suggests it is possible to invest $50K into oil and gas and then write off $45K in intangible drilling costs that same year. He warns it does increase your AMT however. My big beef with this idea is that you never want to buy an investment just for the tax benefits. The investment has to make sense on its own first, and the tax benefits should be gravy. My little beef with this is that I don’t know much about oil and gas and would need to find someone I trusted to assist with that investment. It’s a nice idea, and maybe I’ll delve in there at some point in the future, but not something I’ll be implementing any time soon.

It was nice to have Scott take a look at things. Maybe I’ll even use him in the future to prepare personal or business tax returns. If you’re interested in meeting with a tax strategist, I’m sure he’d be willing to help out. [Disclosure: Since I wrote this, Scott now advertises here at the WCI and a number of readers have availed themselves of his services.]

What do you think? Have you ever met with a tax planner or strategist? Does your tax preparer do these sorts of things with you? Do you have a C Corp? Why or why not? Comment below!

 

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Income By Race: Why Is Asian Income So High?

For the first time in eight years, median income actually increased in America by a healthy 5.2% to $56,516 according to the Census Bureau’s annual income and poverty report. We’re just now getting back to 2001 levels, which means the middle class is falling behind the “investor class” given the real estate market in most major cities and the stock market are near record highs.

Your day job income should be only one source of income. You must build multiple income streams if you want to achieve financial independence sooner. Further, you should continuously invest due to inflation.

Why Is Asian Income The Highest?

The most interesting data from the Census Bureau’s survey is about income by race. Take a look at this chart compiled by The Wall Street Journal.

Income By Race

Asian median household income: $78,000

White median household income: $62,000

Hispanic median household income: $46,000

Black median household income: $37,000

It’s surprising how much quicker/steeper the income recovery is for Asians, followed by Hispanics, Whites, and Blacks. What’s also interesting is how the income gap between Asians and other races seems to be widening. What’s going on here?

Here’s the short version from an Asian American’s perspective.

1) Smaller population, less “weight”. Asians account for only ~5.5% of the American population. One stark example of the benefits of having a smaller population is to take a look at Singapore and Malaysia. The per capita GDP in Singapore is an impressive $56,000, partly because its easier to take care of and mobilize 5.4 million people than it is to take care of 30 million Malaysians, whose GDP per capita is only $11,000. They used to be one country until Singapore split on August 9, 1965.

2) Asian immigrants who can afford to come to America tend to be wealthier. It costs money to flee a country for better opportunity. My ~22 year old neighbor from China who bought a $2.25M house is an example. If you’re poor, you’re stuck. Because the US is viewed as having some of the best universities in the world, many wealthier Asian parents send their kids here, Australia, and the UK. If you can afford to pay US private school or out-of-state tuition, you are probably wealthier than the median person. There is much less financial aid for international students. In fact, many colleges purposefully try and court international students because they pay top dollar.

3) Tremendous focus on education. Education is emphasized more than anything else in the Asian household. Get good grades, go to college, or else be a disappointment. Ever wonder why there are so many Asian dentists, doctors, and lawyers? More education is correlated with higher income and wealth. A 2013 Nielsen Research Report found that Asian American households have a median net worth of $89,300 compared to $68,800 for overall US households, a 30% difference. Meanwhile, roughly 49% of Asian Americans have Bachelor’s degrees vs. 28% of the general US population, a 75% difference.

4) More working people in each household. How do people afford to live in expensive Hawaii where there are few high paying jobs?  Multiple incomes under one roof. It’s not uncommon to see a father, a mother, an adult son and his wife all live together and work. It’s common to see multiple generations under one roof in the Hispanic community as well. Family versus independence from family is highly emphasized.

US Population By Race Chart

What Is Considered Asian?

The biggest pushback from academics and Asian people is the classification of the word “Asian.” Thai culture is very different from Chinese culture. Japanese culture is different from Filipino culture. Every Asian race has its own language that can’t be easily understood by another Asian race. Meanwhile, some Asian countries like India have 22 official languages and 150 languages spoken by a sizable population!

Academics are afraid of the “model minority”, which unfairly puts pressure on different Asian races who may not fit the mold. Can you imagine being an Asian who doesn’t do well in school and isn’t in a profession that requires a graduate degree? Expectations can hurt people’s happiness and pride.

Check out how many different Asian people there are from this Wikipedia chart.

The Different Types Of Asians In America

Now that we understand not all Asians are the same, I want to share my personal thoughts on race and income from a Chinese American person who came to the United States for 9th grade and never left. My father was born and raised in Hawaii, as were his parents. My mother was born in Taiwan, and met my father in college.

Growing Up As An Asian American

With language and cultural headwinds, why is the Asian American income so much higher than average? There’s no proof Asians are any smarter or harder working than other races. I quit math after junior year in high school because I hated math and didn’t see the practical use of taking Calculus in day-to-day life. I also like to lounge around as much as anyone.

I can’t speak for all Asian Americans, but I can provide some perspective as a Chinese American who grew up in four different Asian countries for 13 years before coming to America for high school and college. I was born in the Philippines and lived in Japan, Taiwan, and Malaysia. In college I studied abroad in China for six months. In the workplace, I took business trips to India, Thailand, Hong Kong, Japan, and Indonesia for 13 years in a row from 1999 – 2012. I’ve lived in the States for the past 25 years.

Experiences That Shaped The Soul

When I was in the 4th grade in Taiwan, a White kid tripped me on the pitch and proceeded to yell racial slurs after I fell to the ground. He kept on barking obscenities until I swept his legs and stomped on his solar plexus in retaliation. He began to cry and we were both sent to “face the wall” for the entire afternoon recess period.

While we were squishing ants climbing on the brick just inches away from our faces, my assailant surprisingly turned to me and apologized. I was touched and apologized right back. We never fought or played dirty on the pitch again.

The soccer game was between “Chinese” vs. “Americans” while I was attending Taipei American School in the early 1980s. I was placed on the Chinese team due to my ethnicity, instead of my nationality. I was too young to understand that I had just experienced my first racial conflict.

When I was a sophomore attending The College Of William & Mary in Williamsburg, Virginia, I had another very memorable racial encounter. My girlfriend (who was half-Asian and half-White) and I were eating some midnight waffles at Denny’s, of all places when a group of offensive linemen came barging in. They sat in the booth next to us and told us to “get the fuck out you chinks” or else they’d beat the crap out of us.

By this time, I was already used to racial conflict as a 20 year old Asian American living in Virginia for the past seven years of high school and college. I always spoke up when there was an injustice, but this time I was outnumbered four-to-one. Although I mentally strategized on how to debilitate my oppressors, my girlfriend and I decided to leave as we were just about finished with our food anyway.

I felt ashamed I couldn’t do anything to fight for my girlfriend’s honor. A week after the incident, I made myself a promise to be financially independent as soon as possible so I would never have to take abuse from anybody again. If my loved ones encountered racial hate, then I wanted to have financial means to solve the problem beyond my fists.

Why Asian Americans Save And Earn So Much

Building wealth starts with savings. There is no such thing as investing, buying a home, or building alternative income streams without savings. Let me share with you reasons why I think Asian Americans save and earn more than the median. Again, this is just one person’s point of view.

1) Asians are allergic to debt. Taking on debt to purchase a car, a piece of property, or stocks is a relatively new concept for many Asians. We’ve been taught the tenet, “If you can’t pay for something in cash, you can’t afford it.” This tenet runs counter to the heavy consumerism culture in America. If you go to any property developer in China, it is common for 80%+ of the units to be purchased with cash compared to less than 40% in America. The same trend continues in India. Debt is slavery. Cash is freedom. The US personal savings rate is roughly 4.8% according to the US Bureau Of Economic Analysis compared to 30%+ in places like China and India.

2) Lots of historical uncertainty and upheaval. When you have political instability and war, people tend to save more for their uncertain futures. Over the past 100 years or so, there have been a lot of tragedies in developing Asia. The Cultural Revolution and the Nanjing Massacre are two such tragedies in China. The ongoing heavy hand of the government may be another. The Taiwanese are perpetually paranoid the Chinese will invade. The Japanese have been aggressively saving since their bubble collapsed in the 1980s due to deflation. The 1997 Asian Investment Crisis destroyed the wealth of millions of Thais, Indonesians, Malaysians, and South Koreans. Meanwhile, America has enjoyed a much more stable path of growth thanks to our Democratic system. Having better expectations of the future gives you more confidence in spending more money.

3) Few Asians in leadership positions. When there are hardly any Asian American politicians, actors, and CEOs, it’s more difficult to visualize yourself in such positions as a kid. After all, the Asian population is small. When there are few examples to aspire to, there’s a tendency not to even bother. Instead, Asians may just decide to be their own boss through entrepreneurial endeavors e.g. restaurants, convenience stores, laundromats, landlording, online businesses, etc. Entrepreneurship tends to be much more lucrative than being a median income worker over the long term.

4) Family finances. It’s common to see post-college Asian adults still live at home with their parents. Why pay rent when you can live with the parents and save money for a downpayment, is a common way of thinking. There’s also the traditional aspect of living at home until one gets married, unlike US culture, which encourages independence as soon as possible. If you save $30,000 a year in rent for 8 years until age 30, you will likely be better off financially than average. Personally, I could never imagine living back home with my parents after college. Related: A Massive Generational Wealth Transfer Is Why Everything Will Be OK

5) Sports is not a realistic way out. Only a tiny percentage of the population ever become professional athletes. But the odds are even starker for Asian Americans in athletics, an area where meritocracy reigns supreme. There are hardly any Asian American basketball, football, or baseball players for example. And these three sports are a part of Americana where the best athletes are revered as heroes. Even for non-contact sports like tennis, there’s only been a handful of Asian athletes who have risen to the top of the ranks. You’re only making $100,000 – $150,000 a year before travel expenses as the 100th ranked tennis player in the world. Without the hope of athletics, the only way left is in the field of academics and the arts.

Education attainment by race

Source: Pew Research

6) Academics is the main level playing field. If you study harder, you will likely get better grades. If you get better grades, you’ll likely get into a better university. If you get into a better university, you’ll likely get a better job and make more money. It doesn’t matter if you’re only 5 feet 1 inches tall, you’ve got the same opportunity as someone 6 feet 10 inches tall in academics. Even if you are poor, so long as you have a stable household you can still study as long a someone who is rich. There is nothing more important to the Asian American population than academics. Parents will do absolutely anything to help give their kids a chance to excel in school – from after-class tutors every day to Sunday school.

7) Lower divorce rates. Asian-American families divorce at roughly half the rate of other Americans. There is a stronger social stigma against divorce in the Asian community. Although most marriages occur due to love, practical reasons for marriage may be more common. For example, arranged marriages can be found in Indian and Chinese culture to a lesser extent. I have Asian friends who aren’t romantically in love with their husbands, but stay together due to social pressure and convenience. If you have a more stable household, finances tend to be stronger and children tend to have a better chance of going to college and finding a better paying job.

Divorce Rates By Race

The Realization Nobody Will Save Us

Given Asian Americans account for only ~5.5% of the US population, many Asian Americans realize that nobody is going to save us – not the government, not our colleagues, not the NBA, not the majority. Even if every single Asian American was brilliant and physically intimidating, we’d still get crushed by everybody else as a minority.

The only people Asian Americans can count on are our immediate family and education. This is why you see such a concentration of Asian minority groups in various urban settings e.g. Chinatown, Koreatown, Japantown. It’s a similar concept to why schools of fish swim together in the great unknown ocean.

My father explained to me after my fight on the pitch that this sort of racial conflict would keep on happening as I grew older. He was absolutely right. He taught me that in order to stop getting picked on I would have to fight back with my mind because there’s always going to be someone physically bigger and more intimidating than me. And even if I was a hulk with a black-belt in martial arts, a pip-squeak with a gun could end everything in a hurry. With his advice in mind, I started taking school much more seriously.

When I graduated from college and got my first job in NYC I decided to save as much money as I could. After the first year, I maxed out my 401k and saved 20% of my after-tax income. Yes, it sucked sharing a studio with my high school buddy as a 23 year old, but these are the types of sacrifices I had to make in order to save. Getting in at 5:30am and lasting until 7:30pm in order to eat the free cafeteria food wasn’t so bad.

After my third year of work, I was regularly saving 50% of my after-tax income because all I could think about, when it was dark coming in to work and dark leaving work was how wonderful financial independence would be. My goal was to make the most money as soon as possible in order to break free.

Income By Ethnicity In High Technology

Burn Your Boats

Perhaps it’s easier making and saving money as a minority in America because there’s so much urgency to get ahead thanks to a tiny safety net. Going through racial conflict and seeing so much poverty in developing countries really motivates one to aggressively work.

There’s a saying that if you want to succeed, you should burn your boat. Once you’ve got no way to leave, you’ll simply do your best to thrive. But it’s hard to burn your boat when you’re living on SS America, a luxury cruise liner with all you can eat buffet 24 hours a day!

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Related: Net Worth Targets By Age, Income, And Work Experience

Readers from all races, I’d love to get your thoughts on race and income. Why do you think there’s such a disparity in income among races if we’re basically all the same? How much does work ethic, education, family, size of racial population, and family wealth play a part in income level? Wouldn’t it be beneficial for researchers to do a deep dive study on the Asian race to pinpoint certain traits to help all races make more money?